Financial Regulatory Forum

U.S. SEC finds a new asset class for insider trading: ETFs

By Guest Contributor
September 22, 2011

By Stuart Gittleman

NEW YORK, Sept. 22 (Thomson Reuters Accelus) – In its first such action involving exchange-traded funds, the Securities and Exchange Commission charged a former Goldman Sachs employee with trading on confidential information about the firm’s trading strategies and plans he learned while working on its ETF desk.

An SEC official said the facts of the case may be unique. But the element of arbitrage in underlying components of the ETF echoes mutual fund trading probes in 2003 that rocked the industry. 

ETFs are baskets of securities similar to mutual funds, except an ETF’s price changes throughout the trading day and a mutual fund is re-priced after the end of the day.

The SEC Enforcement Division alleged that the trader, Spencer D. Mindlin, obtained nonpublic details on Goldman’s plans to buy and sell large blocks of the securities comprising the SPDR S&P Retail ETF. He tipped his father Alfred C. Mindlin, a certified public accountant, and both men then illegally traded in four of the component securities knowing that Goldman would later execute massive, market-moving trades in them.

The alleged trading occurred in December 2007 and March 2008, when Goldman was the largest institutional holder of the ETF in order to allow its customers to short it. To hedge its long position, Goldman shorted the individual securities in the ETF.

The order instituting proceedings said Spencer Mindlin knew of Goldman’s nonpublic position in the ETF and its nonpublic plans to trade large amounts of the component securities in order to hedge its position by way of his job on the firm’s ETF desk. The Mindlins began buying and selling the targeted securities within months after the son joined the desk, placing almost all of their trades in a brokerage account in the name of another family member.

The order also said Spencer Mindlin, who previously worked as an analyst at Goldman Sachs Execution & Clearing and its predecessor, Spear Leeds & Kellogg, failed to disclose the trading to Goldman.

‘SHARING’ INFORMATION

According to the order, Spencer Mindlin learned of Goldman’s trading intentions from emails he received shortly before he and his father placed their trades, and his calls regarding the family member’s brokerage account were captured on recorded lines.

The order said the Mindlins obtained at least $57,000 in illicit profits through their insider trading before the son was allowed to resign in August 2009, after working for Goldman and Spear Leeds since June 2001.

The Mindlins have the right to respond to the SEC’s charges and to request an evidentiary hearing before an administrative law judge.

Sanjay Wadhwa, deputy chief of the division’s market abuse unit, said the SEC is “aggressively working to identify and prosecute illegal insider trading across multiple markets and derivatives products regardless of the complexity of the trading pattern that we have to unravel in our investigations.”

Wadhwa and George Canellos, director of the SEC’s New York regional office where Wadhwa is associate director, did not predict a focus on insider trading using ETFs and derivatives, like the Mindlins allegedly did, and the facts may be unique to the case.

But arbitraging the components of an ETF is similar to applying the same strategy to the underlying securities in a mutual fund. The 2003 mutual fund trading probes found that some funds let select investors arbitrage their funds by waiting until after the fund was repriced before deciding whether to buy or sell the underlying securities, depending on the fund’s new price.

Investigating the use of ETFs to conduct market manipulation may take a different path, but the 2003 scandal brought in billions of dollars in fines and restitution and was a public relations coup for the regulators vis-à-vis fund investors, especially retail holders.

The author Mark Twain reportedly said history does not repeat itself but it often rhymes. Regulators nursing a black eye or facing tough fights may soon be testing Twain’s aphorism.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.  Compliance Complete (http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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